Banking

Recapitalization Bonds – recapitalization of banks by Government

Updated on
Nov 16,2017 - 08:53:06 AM

Recapitalization Bonds: With the increasing nonperforming assets (NPAs), banking institutions are under severe pressure to gain the momentum to be a part of the great Indian growth story. Over the last 2 years, the non performing assets of the public sector banks have been on a continuous surge despite strong measures taken by the top managements. Amidst this, Finance Minister Jaitely has recently announced an aggressive plan to recapitalize the public sector banks over a period of 2 years by pumping in the money into these banks.

Recapitalization

As the name suggests, recapitalization means infusing the new capital into the banks to make them stronger and operate effectively over long run. This is one of popular methods of injecting the banks with additional capital strengthen their balance sheet. The government is the majority shareholder in the public sector banks and the responsibility to bail them out in the cases of severe financial crunch rests with it. As a part of the recapitalization plan, government will issue various bonds and other financial instruments and pump in the money so collected into the public sector banks crumbling with the bad loans.

Key matters in Finance Minister Jaitely’s announcement:

It was stated that an unprecedented amount of Rs 2.11 lakh crore would be infused into the banks over a period of next 2 years. As a part of this plan, government will issue bonds worth Rs 1.35 lakh crore to the banks and the banks will buy these bonds by paying the issue price to the government. And the government will purchase the shares in the public sector banks by injecting the money so procured through the issue of these bonds.

After demonetization of the 500 and 1000 rupee denominations, banks have been flooded with the new deposits. Though these are returning back into the hands of the customers in the form of withdrawals, there is still a considerable amount in the hands of banks which can be utilized to purchase the recapitalization bonds. However the government has not yet announced the details as to how these bonds will work.

Are recapitalization bonds new to India?

No, During 1990s recapitalization bonds have been used to help the banks function better but the amount of the plan was smaller. The bonds issued then were marketable which means that the banks holding these bonds can further trade them and raise money by easily trading them to the buyers.

Interest:

These bonds will carry an interest rate which could be very low as this is a part of the financial engineering to boost the balance sheet of the banks. And the government will pay the same out of its own money along with the face value during the period of redemption.

Fiscal deficit & Accounting:

As per IMF norms, these bonds will not be a part of the government balance sheet. Thus they will not affect the fiscal deficit. Since these are mere currency neutral transactions where liability of bonds is countered by the investments made by the government out of it, it won’t have any impact on the fiscal position of the government except to the extent of the interest payable on these bonds.

Bottom line:

It is stated that Indian banking sector is suffering from the trauma of nonperforming assets worth Rs 10 lakh crore. This will erode the capital and reserves of the banks to the extent written off. But the boost that the government has planned to give could help the banks handle their lending and operational requirements by effectively bailing out the bad loans.